QLACs Can Reduce Longevity Risk For Some

Longevity reduces retirement readiness for defined contribution plan participants, but purchasing a qualified longevity annuity contract (QLAC) can help, an analysis from the Employee Benefit Research Institute (EBRI) finds.

As part of the assessment of the impact of longevity on retirement income adequacy, EBRI used its Retirement Security Projection Model (RSPM) to establish relative-longevity quartiles based on family status, gender, and age cohort. For the Early Baby Boomers simulated to die in the earliest relative quartile, the Retirement Readiness Rating (RRR) of 75.8% was 19.1 percentage points larger than the overall average for this age cohort. The RRR decreased to 63.1% in the second relative-longevity quartile and 44.9% in the third relative-longevity quartile. For the Early Boomer cohort with the longest relative longevity, the RRR fell all the way to 37.9%.

Similar patterns were found for the younger age cohorts, but there was a noticeable increase in the RRR range between the earliest and latest longevity quartiles: 37.9 percentage points for Early Boomers, 41.3 percentage points for Late Boomers, and 49.2 percentage points for Gen Xers.

In 2014, the U.S. Treasury Department and the Internal Revenue Service (IRS) issued final rules for creating a QLAC that would be exempt from the required minimum distribution rules that dictate distributions from defined contribution (DC) plans and individual retirement accounts (IRAs) must typically begin by age 70 1/2. EBRI modeled two scenarios under which QLACs are utilized as part of a 401(k) plan, and found that, even at today’s historically low interest rates, the transfer of longevity risk to an insurer under a QLAC provides a significant increase in retirement readiness for the longest-lived quartile, compared with only a small readiness reduction for the general population.

In the first scenario, 15% of the participant’s 401(k) balance would be converted to pay a QLAC premium while simultaneously attempting to partially mitigate the risk of purchasing the product when interest rates are low. The second proposal assumes (some) plan sponsors would be willing to convert the accumulated value of their 401(k) contributions to a QLAC purchase at retirement age on either an opt-in or opt-out basis for the employees.

Results show the percentage change in Retirement Readiness Ratings that result from purchasing a 10-year laddered QLAC of 1.5% of 401(k) account balances from ages 55 to 64 for households in the longest relative-longevity quartile with a QLAC, as well as the impact on all households with a QLAC. In the first scenario, the increase in RRR for Early Boomers in the longest relative-longevity quartile with a QLAC is only 1.9%, but it increases to 2.9% for Late Boomers and 3.5% for Gen Xers. EBRI says the larger percentage increases for the younger cohorts are largely a function of their larger 401(k) balances as a multiple of earnings.

When the premium rates are decreased by 10%, the percent increase in the RRRs (compared to the baseline of no QLACs) vary from 2.5% for Early Boomers to 4.6% for Gen Xers. A 20% decrease in premium rates increases the range of RRR increases to 3.2% for Early Boomers and 5.3% for Gen Xers. A 30% decrease in premium rates increases the range of RRR increases to 4.5% for Early Boomers to 6.7% for Gen Xers.

In the second scenario, the increase in RRR (compared to the baseline of no QLACs) for Early Boomers in the longest relative-longevity quartile with a QLAC is 6.7%, but it increases to 7.3% for Late Boomers and 8.7% for Gen Xers. Similar to results for the first scenario, the RRR increases for each cohort when premium rates are decreased.

A full report of the analysis can be found in the August 2015 EBRI Notes publication on EBRI’s website.